Will India Replace China As A Destination For Foreign Capital?

For 2016, emerging market investors may have to look beyond China to its neighbor India.

A Pause In China's Growth Story?

The recent rout in China's stock market that reverberated through the world's stock indices is the the latest in a series of signs that China is falling out of favor with investors. (See also: China Continues To Roil Global Markets.)

The Asian giant was long been a favorite with investors for most of the 1990s and the previous decade. Even as the world was wracked by the greatest financial crisis since the Depression, the country played a critical role in keeping the global economy on an even keel by remaining a safe haven for foreign investors and multinational companies due to its growth prospects. The country's manufacturing exports fueled demand in commodities, and infrastructure spending by the government propped up industry. However, the country's pivot away from manufacturing to consumption, which started last year, has been rocky as a number of key indices, such as its purchasing managers' index, have dipped to levels not seen in more than a decade.

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India Steps Up To The World Stage

Even as China's growth story seems to be stalling, India's is revving up. The country has already been insulated from headwinds in the global economy due to a number of factors. For example, restrictions on foreign ownership of bonds have helped buffer its bond market from the volatility affecting global bond markets. Even as the Russian ruble crashed against a strong dollar, the Indian rupee has been one of the only currencies to gain against the greenback. Similarly, the turmoil in China's economy, which tipped Brazil into a recession, has not affected India because its Asian neighbor accounts for only 5% of total exports from the country.

The election of Narendra Modi, widely perceived as India's most pro-business leader in political circles, also signals a change in the country's moribund bureaucracy and industrial climate. Modi has instituted a number of reforms, pushed through bills to open up sectors of the economy and cracked down on corruption and slack in Indian's infamous bureaucracy. He also embarked on a number of foreign jaunts to attract foreign investment into the country. Acting in concert, the country's central bank instituted a number of rate cuts to make credit accessible and bolstered foreign exchange reserves.

The results are beginning to show. The current account deficit, which had ballooned to 5% of the country's GDP, is now below 2%. Similarly, inflation was almost 11% in 2013 but dipped down to a manageable 6.4% in 2014.

According to ratings agency Moody's, India is "less exposed to global risks because of its more resilient economic growth and the impact of positive policy reform momentum." Analysts at Societe Generale predict that the Bombay Stock Exchange will rally in 2016. The IMF has also predicted economic growth figures of 7.3%. Goldman Sachs (GS) predicts growth in emerging market indices and included India among countries with strong growth prospects in 2016. Silicon Valley has also gotten into the act investing boatloads of cash in local e-commerce startups based on the promise of exponential returns due to the smartphone revolution.

The Bottom Line

According to analysts, China's rebalancing from manufacturing to consumption will take another three to four years. The period during this pivot in the country's economy will be painful with unpredictable growth and returns. In the meantime, investors should consider its neighbor India. The election of a pro-reform and pro-business government coupled with a young population demographic makes the world's largest democracy an attractive place to park your funds.